Markets & Finance

Stocks: A Stiff Upper Lip

July 10, 2005

By Mark Arbeter Investors have learned that one-time market shocks have historically shown only temporary consequences for the stock market and it is best not to panic into weakness. The downside reaction on Thursday, July 7, to the bombings in London was swift, hammering stock markets that were trading and slamming stock futures here in the states. The markets settled down very quickly this time, and by lunchtime Thursday, the major indexes were all back where they finished Wednesday.

In our opinion, there is no question following Thursday's news flow and the action of the stocks, that the market showed a lot of resiliency. We believe, however, that some of the action in other related markets had something to do with this. Crude oil futures took quite a hit early in the day, recovered but still finished off almost 1%. Crude oil had been and, in our opinion, still is in a fairly powerful rally. Bonds, which we believe are also putting in a bottom with respect to yields, rallied on safe haven buying, pushing the 10-year Treasury back near 4%.

Prior to Thursday, the market tried to rally but volume was once again unimpressive. On Tuesday, July 5, the S&P 500 jumped 0.9% with the Nasdaq rising a little more than 1%. On this fairly strong market day, volume on the NYSE was only 1.37 billion shares, below the 50-day moving average of 1.45 billion shares. On the next day, the markets reversed, giving up most of their gains on a pickup in volume to 1.45 billion shares. The volume on the Nasdaq during Tuesday's strength was well below average. We have seen this pattern on a consistent basis of late, where down days are seeing a pickup in volume and up days are seeing lower than average volume.

So where does this leave the market? We'll have to give the bulls the upper hand in the near term. The reversal Thursday was impressive for a couple of reasons. The obvious one is that the market reacted positively to negative news. Secondly, the S&P 500 and the Dow Jones industrial average broke near-term chart

support on an intraday basis on Thursday, and appeared technically that they were finally breaking down. The S&P 500's recent closing low of 1190.69 was taken out during Thursday's session, but the index rallied sharply and finished back above this support level. In the process, the S&P 500 traced out a bullish (short term) candlestick known as a hammer.

In essence, we believe the market was hammering out a bottom. The DJIA put in a similar formation as the S&P 500. The DJIA's recent closing low of 10,271 was broken intraday Thursday, but the index managed to retrace all its losses and closed above this short-term support level. So technically, the market was in a position to fold but the bulls came to the rescue. In our view, that is bullish action and could set the indexes up for a rally to the top of their recent trading ranges.

The S&P 500 found plenty of technical support on Thursday, besides support from its recent trading range. The 50-day exponential moving average comes in at 1193 while

trendline support, drawn off the lows in April and May lies at 1192. In addition, there was a heavy volume day or heavy day of accumulation on May 18 and the range for that day was 1174 to 1188. The intraday low on Thursday was 1183.55.

The Nasdaq, unlike the S&P 500 and the DJIA, never broke below the bottom of its recent range of 2045 on a closing basis, and appears to have finally busted through very stiff

resistance in the 2100 zone. A strong break above 2100 would then set the stage, in our opinion, for a move up to the highs saw earlier in the year up in the 2180 to 2200 area. Daily and weekly momentum indicators based on the Nasdaq are in mostly neutral territory, giving the index room to run on the upside, in our opinion. Accumulation/distribution models, based on advancing and declining volume, are also neutral but improving.

The bond market benefited from a flight to safety on Thursday but reversed and got hit pretty hard on Friday. Yields on the 10-year Treasury note closed the week at 4.11%, the highest since mid-June. A break over 4.13%, which was the high yield during the current pattern, would complete a

double bottom formation in yields and target the 4.3% to 4.4% area over the next couple of months. Momentum, after getting very overbought, is in bearish configurations, and suggests that yields are heading higher, in our view.

Glossary

S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.

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A+

Highest

B

Lower

A

High

C

Lowest

A-

Above Average

D

In Reorganization

B+

Average

NR

Not Ranked

B-

Below Average

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S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations and 12.5% with sell recommendations.

In Europe

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations and 20.3% with sell recommendations.

In Asia

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations and 17.7% with sell recommendations.

Globally

As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations and 13.8% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

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